As a business owner, you must continuously monitor your business’s financial health. As part of your ongoing profitmaking endeavors, you will work closely with banks and lending institutions who will need to see your financial statements occasionally. A robust, ongoing relationship with your banker will be beneficial when you seek a loan or an independent endorsement of your growth plans to your board of directors.
Why Do Banks Ask for Financial Statements?
When you approach a bank for a loan, they need certain pieces of information to weigh the pros and cons of lending to you. Financial statements provide a snapshot of your business’s financial health, performance, and potential. Here’s why banks request your financials:
- Risk Assessment: Very simply, financial statements offer insights into your company’s ability to repay the loan.
- Decision Making: Financial statements aid banks in making informed decisions about the loan terms, interest rates, and collateral requirements they can comfortably extend.
- Creditworthiness: Your financial history helps banks determine your creditworthiness. A consistent and positive loan repayment history indicates reliability for the future.
What Financial Statements Do Banks Review?
Banks typically request three primary financial statements: the balance sheet, income statement, and cash flow statement. Each serves a unique purpose in the evaluation process.
- BALANCE SHEET: This statement provides a snapshot of your company’s financial position at a specific point in time. It lists assets, liabilities, and equity. Banks look for:
- Liquidity: The ability to cover short-term obligations. A healthy current ratio (current assets divided by current liabilities) indicates strong liquidity.
- Solvency: Long-term stability and debt management. The debt-to-equity ratio is a key metric here; lower ratios are generally preferable.
- Net Worth: The overall value of your business. Positive equity signals financial health.
- INCOME STATEMENT: Also known as the profit and loss statement (or P & L), this report shows your revenue and expenses over a period, revealing your profitability. Banks focus on:
- Revenue Trends: Consistent or growing revenue streams are favorable.
- Expense Management: Efficient cost control and a healthy profit margin indicate good management.
- Net Income: Profits after all expenses, which shows your ability to generate earnings.
- CASH FLOW STATEMENT: This statement outlines the inflows and outflows of cash, highlighting your business’s liquidity and operational efficiency. Key areas of interest include:
- Operating Cash Flow: Cash generated from core business activities. Positive cash flow suggests sustainability.
- Investing Cash Flow: Investments in assets or securities. Banks prefer seeing strategic investments that could lead to growth.
- Financing Cash Flow: Loans and repayments. A balanced approach to financing indicates prudent financial management.
What Do Banks Look For?
When reviewing your financial statements, banks assess several key factors:
- Profitability: Consistent profits indicate a healthy business. Banks analyze profit margins and net income to gauge sustainability.
- Cash Flow: Positive and steady cash flow is essential. It shows that your business can cover daily operations and debt obligations.
- Debt Levels: Banks evaluate your current debt load and compare it to your equity. A lower debt-to-equity ratio means less risk for the bank.
- Credit History: Past financial performance and payment history are critical. A strong credit history builds trust and confidence.
- Growth Potential: Banks look for signs of growth and expansion potential. Healthy revenue trends and strategic investments are positive indicators.
- Management Effectiveness: Your financial ratios and statements reassure banks of your business acumen. The three primary financial reports are surprisingly informative as they relate to your management team’s ongoing ability to handle staff, business assets, inventory, marketing, etc., demonstrating success in the face of today’s challenging business climate.
Why Does This Matter?
Understanding what banks look for in your financial statements can help you prepare better and present a compelling case for financing. But the argument for maintaining strong financials goes deeper: You are creating a story that helps your stakeholders—your employees, investors, customers, vendors, and community—know they can trust you. Here’s how everyone benefits:
- Improved Loan Approval Chances: By presenting solid financials, you increase your chances of securing loans with favorable terms.
- Better Financial Management: Knowing what metrics banks scrutinize helps you focus on critical areas, improving overall financial health.
- Enhanced Business Planning: Regularly reviewing your financials keeps you informed about your business’s performance, aiding in strategic planning and growth.
Preparing Your Financials
To ensure your financial statements meet bank expectations:
- Maintain Accurate Records: Ensure your financial records are up-to-date and accurate.
- Seek Professional Help: Consider hiring an accountant to prepare and review your financial statements.
- Conduct Regular Reviews: Conduct regular financial reviews to monitor performance and address issues promptly.
- Be Transparent: Provide clear and detailed explanations for any anomalies or inconsistencies in your financial statements.
- Stay In Touch: Be sure to call your favorite banker before the last minute. Build a relationship. Periodically ask for their advice or an opinion. Buy them lunch or invite them to tour your premises.
Conclusion
Banks ask for financial statements to assess the risk and creditworthiness of your business. By understanding what they look for and why, you can better prepare your financials, improve your chances of securing financing, and enhance your business’s financial health.
Meanwhile, you are confident in your company’s reporting, assured that you’re making a profit, spending time and money in the right places, getting a respectable return on your investments, and making sound decisions for your and your stakeholders’ futures.
If you need help with your financial statements or need assistance, feel free to reach out to financial professionals. Your preparedness today can pave the way for your business’s growth and success tomorrow.
Contact us today for a comprehensive review of your financial statements and expert guidance on improving your financial health.
